Benchmark Price Action Strong Despite Low Investor Expectations!
VIX Options Activity and Short-Term Bullishness!
by Ian Harvey
August 06, 2012
Friday couldn’t arrive sooner enough! After a four-session slog, the bulls retook control to end the week on a high note, lifting the major indexes to a positive weekly finish. Domestic jobs data played a big role in this comeback, as did continued hopes that the 'European Central Bank - ECB' may take steps to lower interest rates.
The Dow conquered 13,000 once again, which is even more of an achievement -- as pointed out below -- given the overwhelming amount of bearish sentiment – low investor expectations -- shrouding the market. Also observed is a notable shift in the CBOE Market Volatility Index (VIX) options pits on Friday, and the effect this will have on short-term bullish investors.
Stocks are Up 10% in 2012 – Why the Bearish Sentiment?
“…..Implications for the immediate term were the slashing of GDP forecasts by at least three major banks. After GDP forecasts were cut…. earnings displayed what could be a pretty decent growth story..….engines of the economy -- the consumer and small business -- seem to be in better shape than headlines suggest…..This may allude to the fact that perhaps the slowing in economic growth is not as bad as advertised. Time will tell, but judging by the resilient stock market, there might be something to this. At the very least, a lower-expectation environment should be viewed as a good thing for stock investors. In other words, if economic growth indeed meets the lowered expectations, it will not come as a major negative shock, implying selling would be muted relative to a disappointing economic report amid higher expectations.”
- Options Expiration Expectations , July 16, 2012
"…..Either the world is really coming to an end, or it's a great time to buy stocks. Sell side strategists are as bearish as they've been in 27 years, according to Bank of America Merrill Lynch's Sell Side Consensus Indicator. The indicator fell to 43.9 at the end of July. That's the lowest its [sic] ever been in the 27 years the data's been collected."
- MarketWatch, August 1, 2012
"…..The cult of equity is dying. Like a once bright green aspen turning to subtle shades of yellow then red in the Colorado fall, investors' impressions of 'stocks for the long run' or any run have mellowed as well."
- Bill Gross, PIMCO, August Investment Outlook
"…..U.S. payrolls increased by a seasonally adjusted 163,000 jobs last month, the Labor Department said Friday.... Economists surveyed by Dow Jones Newswires expected a gain of 95,000 in payrolls and an 8.2% jobless rate."
- The Wall Street Journal, August 3, 2012
"……U.S. services activity accelerated in July, according to data released Friday by the Institute for Supply Management. The ISM services index ticked higher to 52.6% from 52.1% in June, compared with analysts' expectations of 52%."
- MarketWatch, August 3, 2012.
The above excerpts give you an feeling or more succinctly – an indication -- for the extremely low investor expectations environment in which we are currently operating. Admittedly, the headline risks are many, identified each day in the financial media (Europe's sovereign debt crisis, slowing growth in emerging markets and domestically, political/regulatory/fiscal uncertainty, to name a few).
TOP OPTIONS TRADES SINCE JUNE 01, 2012
|HLF July 47.50 Calls||53%||APPL Aug 650 Calls||67%|
|DLTR Aug 110 Calls||32%||UIS Oct 17 Calls||79%|
|HSY Aug 70 Calls||56%||TSO Nov 25 Calls||54%|
|NKE Oct 92.50 Calls||49%||HLF July 47.50 Calls (again)||38%|
|FB Aug 25.00 Puts||500%||DISH Sept 30.00 Calls||100%|
|APPL Jan 13 650.00 Calls||71%||CSTR Oct 42.50 Puts||400%|
|LNKD Aug 92.50 Puts||30%||LNKD Aug 100.00 Calls||250%|
The Investor Expectations Environment
As discussed in the article on July 16 -- ‘Options Expiration Expectations ’ -- "a lower investor expectations environment should be viewed as a good thing for stock investors." This should also sit well for all the contrarian investors in regard to the risk-reward in the market when benchmark price action is strong in the wake of this underlying fear. Such is the case at present, with the Standard & Poor's 500 Index (SPX – 1,390.99) gaining more than 10% year-to-date and doubling in value (and then some) from its March 2009 low.
Essentially, such investor expectations environments tip the risk-reward equation in favor of the bulls. Any negative news is discounted into the market as investor’s underweight stocks by raising cash or carrying larger-than-normal short positions. Therefore, selling is muted when widely followed reports meet lowered investor expectations, as many investors have already prepared their portfolios in anticipation of bad news. On the flip side, sharp rallies become the norm when data exceeds investor expectations, as we witnessed with Friday's jobs number.
As we are well aware, this is a market that can and will react to both positive and negative headlines from day to day and week to week. But looking at the bigger picture, you have to be impressed with the price action, even as:
1. Wall Street strategists recommend an extremely low allocation to stocks.
2. Short interest on SPX components is near its highest level since last year around this time.
3. Retail investors are consistently shifting out of domestic equity mutual funds.
4. Hedge funds remain underweighted in U.S. equities.
5. There have been more bears than bulls in the weekly, American Association of Individual Investor (AAII) survey, the third-longest consecutive streak since 1987.
The option activity on the CBOE Market Volatility Index (VIX – 15.64), with the SPX at 1,379.00, is the lowest in 2012 - 161,210 contracts today vs low of 172,353 on 6/27, which preceded a 3.2-percent rally in [four days].
As you can see on the chart below put volume has been extremely low for the past several weeks, a sign that few are expecting a decline in volatility (which is usually associated with a market advance).
Whether the lack of put volume is due to a low number of traders expecting a short-term rally, or shorts so confident in their positions that they are not seeing the need to hedge, low VIX put volume is a sign that very few expect a rally in the market -- low investor expectations! This is fascinating because huge rallies occur when least expected.
As a side note, such pessimism may be changing, as put volume on VIX options surged in Friday's trading. This could be a short-term tailwind for the bulls, as increased VIX put buying is hedged by the floor via S&P futures buying. Moreover, high VIX put volume could be a sign that fear is receding -- as optimists return, there could be a strong bid for the market.
The Significance of the SPX Level
One level to watch this week is 1,360 on the SPX, which is important to the market movement. Not only was this level the site of the index's close just ahead of ECB President Mario Draghi's July 26 comments (which hinted at imminent actions by the ECB to stem the European debt crisis), it is also the 61.8% Fibonacci retracement level of the early April high and early June low and served as an area of support in mid-April. Potential resistance, meanwhile, is in the 1,420-1,425 area, site of this year's early April high.
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Further Articles Relating to the Week Ahead
1. The Week Ahead in the Stock Market - August 06, 2012
2. The Economy and Earnings in the Week Ahead – August 06, 2012
3. The Past Week Stock Market Results – August 06, 2012
4. The Major ETFs in the Week Ahead – August 06, 2012
5. August Seasonality - Indicator of the Week – August 06, 2012